Can Gold Swim in a Crosscurrent?

Arkadiusz Sieron Posted Dec 29, 2018

Powell noticed some crosscurrents in the path of the US economy. Will it stay on the surface? And is gold a good swimmer?

Crosscurrents Cause Fewer Hikes

We hope that you enjoyed Christmas. As we promised last week, we will analyze the post-meeting Powell’s press conference today. The Fed Chair remained optimistic about the US economy, which “has continued to perform well.” However, “some crosscurrents have emerged.” Powell meant the moderation of global growth, increased financial market volatility, and tightened financial conditions. As a consequence, the Fed now sees only two instead of three hikes in 2019:

Many FOMC participants had expected that economic conditions would likely call for about three more rate increases in 2019. We have brought that down a bit and now think it is more likely that the economy will grow in a way that will call for two interest rate increases over the course of next year.

Well, it seems that either Powell feared Trump’s anger or he followed Greenspan, Bernanke and Yellen, and introduced its own put, after all. Trump and Wall Street 1:0 Powell and Co.

Have You Shifted Tone, Mr. Powell?

When it comes to the Q&S session, the journalists touched on interesting issues. A few of them were about still subdued inflation despite strong economic growth and low unemployment rates. The funny thing is that the Fed undershot its inflation target for the seventh year straight. Unfortunately, Powell dodged the question, but he sent another dovish signal, saying “So, I do think that gives the Committee the ability to be patient in moving forward.” Excellent, gold adores patience, it’s eternal asset.

Another fascinating set of questions was about the neutral interest rate. One journalist pointed out that in October, Powell said that interest rates were a long way from neutral. While a month later, he argued that interest rates were just below neutral. Again, Powell did not actually explained the reasons for that change. Moreover, he modified his stance again, saying that “we’re at the lower end of the range of neutral”. Another month, another change!

However, it’s a strange statement. We, of course, do not know what models Powell uses. But please take a look at the heatmap of the Taylor rule prescriptions for the federal funds rate below. It was prepared by the Atlanta Fed.

(Click on image to enlarge)

As one can see, no measure of the neutral interest rate (each row reflects different method of estimating r*) places the Fed at the lower end of the range of neutral. So, according to the Fed’s own estimations, and contrary to Powell’s remarks, the US monetary policy is still accommodative. It’s good news for the gold market.

Implications for Gold

Overall, Powell’s press conference was rather dovish. Although he tried to assure that the recent development “have not fundamentally altered the outlook”, the FOMC slashed its projected number of hikes from 3 to 2 next year. Moreover, although it contradicts the Atlanta Fed’s models, Powell claimed that the federal funds rate had actually achieved the range of neutral rate. If the interest rates are within that range – while inflation is subdued, and economic growth is slowing down, so there is no need to be restrictive – it means that the Fed is behind the peak of its tightening cycle.

From the fundamental point of view, it is a positive change for the gold market. Less aggressive Fed means weaker support for the US dollar. If we add the possibility that the ECB will finally raise its interest rates in the second half of 2019, it turns out that gold may perform better next year.

Anyway, 2019 will be very interesting. For example, please remember that there will be press conference for each FOMC meeting. In the January edition of the Market Overview, we will elaborate on 2019 outlook for the gold market. Stay tuned – and Happy New Year!

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Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.